SEC's Insider Trading Proposal: Good Politics, Bad Policy

by Jonathan R. Macey

Jonathan R. Macey is a professor of law at Cornell University.

Executive Summary

Although the ethical and economic aspects of insider
trading regulation have been discussed at length, only recently
have commentators begun to examine the political aspects of
this practice.[1] The virtual total neglect of the political
side of the story is particularly curious in light of the fact
that regulation of insiders' trading practices has become a
highly politicized issue and has prompted numerous hearings[2]
and bills[3] in Congress.

At present, a battle for the right to regulate insider
trading is being fought among Congress, the regulators at the
SEC, and the federal judiciary. Each of these organizations
has an institutional (if not political) interest in regulating
the trading practices of insiders, and those interests are
reflected in the regulations and proposals they have promulgated.

Not surprisingly, the federal judiciary, insulated as it
is by the relative independence from political pressures
brought about by Article III of the Constitution, has promulgated the most sensible--though not thoroughly sensible--rules
about insider trading.[4] It is dissatisfaction with these
rules among powerful political constituencies that has led the
SEC and Congress to attempt to abrogate the clear rules
developed by the Supreme Court and the lower federal courts
over the last several years.

With an aim of exploring more deeply the political aspects
of the current debate on insider trading, this essay begins by
examining the political implications of the rules on this
subject that were generated by the Supreme Court in Chiarella
v. United States[5] and Dirks v. Securities and Exchange
Commission[6] and clarified in a series of lower court decisions. These two decisions brought both clarity and coherence
to the law of insider trading, which previously had been a bog
of confusion. The decisions also represented major defeats of
the SEC's concerted attempts to use the rules against insider
trading to advance its own bureaucratic ends.

Powerful special-interest constituencies of Congress and
the SEC were dissatisfied with the rules generated by the
Supreme Court. Their dissatisfaction led to the promulgation
of the SEC's recently proposed compromise statute, which
purports to define the crime of insider trading for the first
time.[7]

The proposed statute reflects the interests of those
constituencies rather than the proffered public-interest goal
of protecting the "fairness, efficiency and integrity of the
Nation's securities markets."[8] Judge-made law of insider
trading evolved from the enactment of SEC Rule 10b-5 to the
Supreme Court's decisions in Chiarella and Dirks.[9] The
courts gradually moved from vague, incoherent "fairness" justifications of insider trading law toward precise, intellectually defensible contract-based justifications of such law.
Recently, however, the locus of lawmaking on the subject of
insider trading has shifted from the federal courts to Congress. The result has been the triumph of politics over
principle.